EU Financial Reform: First steps

I've been trying to post something for a while about recent fiscal developments at the EU level and suggestions of a EU tax. However it's taken a lot of time as I keep on getting distracted.

In the mean time some tentative words on the agreement reached recently on EU reform, between the Commission, Parliament and the Council. Some extracts below from...

Jean Quatremer interviews the Greek finance minister

The full article as it was published online in his blog at the website of Libération, can be found here. I've excluded the introduction. I am impressed by the apparent serenity of the Greek official. Please check ou the original website for more content. There's a particularly intriguing article about British disinformation and the Greek isles of the Aegen sea... You do however need to read French to follow the article. Alternatively run it through google translate. Here it is:

VoxEU and Policies for a Europe in a Fiscal Crisis

VoxEU, that "not-for-profit" beakon of economic thinking, has released a very good eBook on the ongoing fiscal crisis, edited by Richard Baldwin and Daniel Gros. I take the liberty of pasting the table of contents from the link above. If you have any interest in economic policy and the future of the EU, you can't miss this.

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The eBook’s Table of Contents

Completing the Eurozone rescue: What more needs to be done? Edited by Richard Baldwin and Daniel Gros

Introduction: The euro in crisis – What to do? Richard Baldwin and Daniel Gros

Drawing a line under Europe’s crisis Barry Eichengreen

The Eurozone needs a political union, or at least elements of one Paul De Grauwe

The Eurozone's levitation Charles Wyplosz

Eurozone governance: What went wrong and how to repair it Jean Pisani-Ferry

The European bicycle must accelerate Angel Ubide

What more do European governments need to do to save the Eurozone in the medium run? Thomas Mayer

The narrative outside of Europe about Europe’s fiscal crisis is wrong Avinash D. Persaud

Rethinking national fiscal policies in Europe Philip R Lane

A credible Stability and Growth Pact: Raising the bar for budgetary transparency Michael C. Burda and Stefan Gerlach

Fiscal policy at a crossroads: The need for constrained discretion Antonio Fatás and Ilian Mihov

Fiscal consolidation as a policy strategy to exit the global crisis Giancarlo Corsetti

German spending is not the cure Alberto Alesina and Roberto Perotti

The long shadow of the fall of the wall Daniel Gros

What are PGS doing?

What are Portugal, Greece and Spain doing about their fiscal positions?

Here's an account. It is rather incomplete, but it gives some insights. For simplicity, and because it is originally in Portuguese, I include the picture below in this post. The conclusion is that they are doing something, and except the unavoidable tax hikes, the reforms seem to be quite positive for productivity, savings and growth. Hopefully some of these reforms will be permanent...

I will also try to see if I can find the links to the Stability and Growth programmes that these countries submitted to the European Commission.

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(This is a late addition to the original post)

For another overview of the situation with the PIIGS, here's what The Economist has to say.

Debt markets in the next two weeks

This article is extremely insightful. However I must disagree with the analogy between Greece and Bear Stearns. This is inappropriate because Greece is getting bailed out, Bear Stearns wasn’t. If anything Greece should be compared to Morgan Stanley who was bailed out.

Moreover, the contagion to Portugal, Spain, Ireland and Italy is similar but on a much smaller scale. When Bear Stern filed for bankruptcy, the devastation was enormous because suddenly reputation was worthless. Therefore markets were unable to know who was in a good financial position and who wasn’t. Bad money crowded out good money which almost brought trading to a halt. In the present situation however markets know that Northern Europe’s credit is good. The doubt is as to whether all of Southern Europe is worse off than its northern neighbours and if so by how much.

Thus reactions are probably extremely exaggerated. Greece cooked its books for some years until it was impossible to hide the mess any longer. Portugal, Spain, Ireland and Italy for all we know have been honest in their reporting. Now of course no one is in a great place right now. Portugal has a private debt to GDP ration above 200% and requires some very fundamental changes in the way its economy works. Spain is going through 20% unemployment rates. Ireland has the EU’s largest deficit this year. So the fundamentals are not quite there, and in the long run it is both predictable and good that the financial markets are putting some pressure on these countries to fix their economies.

I would venture the guess that asymmetries of information between the governments and their lenders are causing the latter to exaggerate the extent of risk that they are exposed to. They are also increasing the effect of rumours and gossip in trading, such as Morgan Stanley's Joachim Fels' argument that the Euro-area is at risk. If this is the case, then things should either get much better or much worse for Portugal, Spain and Italy in the next 2 weeks. On May 12 data pertaining to the first quarter of 2010 about the national accounts of Portugal and the preliminary Italian and Spanish GDP values will be published. On May 19, the Spanish national accounts data will be published and the next day Italy will publish its latest industrial turnover figures.

The dissemination of this information should decrease the asymmetries of information and give a better idea of how solvent these countries are. Of course whether the new data will be favourable to the reporting nations is completely unknown. If it is, sovereign debt yields should shrink. If isn’t, then there might be yet another run on their debts and on the Euro. If the latter occurs, I would expect the ECB to start purchasing national debt on the secondary market in order to limit contagion. This should lower the prices of national debt, while maintaining some institutional pressure on EU member states to reform. All that the ECB has to do is to warn that in the absence of reform it will dump suspicious sovereign debt on the markets, causing a fairly predictable increase in their price.

Until then the markets should continue to behave a bit nervously, at least for another week, unless something new happens, like some oil shock, a or some freak revolution in Greece. Moreover, they will probably go a bit bonkers with the fact that there wont be a clear cut majority in Westminster. The Greek parliament could fail to approve EU/IMF assistance, or the upcoming summit of the council leaders could be either very successful or very unsuccessful in drafting plans for dealing with fiscal problems and reforming the Stability and Growth Pact (Hopefully they'll come up with decent plans for the EMF rather than for an actual European rating agency). Finally some rating agency might downgrade one of these countries yet again. What do you think?

Greece will be bailed out before it defaults or restructures

So it seems that Greece will actually need to be bailed out. Wolfgang Munchau offers a good explanation of the underlying dynamics and mechanisms, while Jean Quatremer provides a more accessible version, for those who speak French. Its particularly relevant in terms of the accounting and maths of it all. Please read them if you have a chance. I must say I identify more with the optimistic perspective of M. Quatremer, in that Greece will be bailed out. I'm not saying it won't default. I'm just saying it will be bailed out and if that's not enough, then it will default. My hope for the bailout is that it will save Greece from falling further into a debt deflation dynamic such as the one described by Jacques Depla, which would then create real lasting problems. If this proves true, then we end up in Wolfgang Munchau's scenario number two, where the EU and the IMF bail out Greece. Contrarily to him I assume that member states can bail each other out, within the limits of some set out by article 103a of the Maastricht Treaty(in page 13), which reads as follows:

"ARTICLE 103 a 1. Without prejudice to any other procedures provided for in this Treaty, the Council may, acting unanimously on a proposal from the Commission, decide upon the measures appropriate to the economic situation, in particular if severe difficulties arise in the supply of certain products. 2. Where a Member State is in difficulties or is seriously threatened with severe difficulties caused by exceptional occurrences beyond its control, the Council may, acting unanimously on a proposal from the Commission, grant, under certain conditions, Community financial assistance to the Member State concerned. Where the severe difficulties are caused by natural disasters, the Council shall act by qualified majority. The President of the Council shall inform the European Parliament of the decision taken."

Granted that all of Greece's problems are not motivated by "difficulties caused by exceptional occurences beyond it control", but they are partially. As long as it is possible to determine that an economic shock is not purely endogenous, this article allows for the intervention of the Council upon a unanimous decision of its members. Given that economics is not an exact science, and that we are unlikely to create a European Court of Macroeconomic Justice, it is fair to say that as long as an economic shock is symmetrical(meaning as long as everyone else is also experiencing a recession), those who are suffering less will always be able to bail out those suffering more, even if everyone is suffering.

I also disagree with Munchau on his last comment that "the message from the EU, and from Germany in particular, is that member states are not ready to co-ordinate economic policy in the short run, and move towards a minimally sufficient fiscal union in the long run, and that as a result EMU is doomed". To me this is a syllogism. I think that the EU is more than the sum of its parts, particularly in terms of institutional reform, which is what is relevant from the point of view of fiscal

Also, if common sense is not a good enough explanation for German self interest in dealing with its neighbours, here is a fairly comprehensive review of all the possible reasons why Germany does not want to offer Greece any outrageous bailout.

This is why we need European independent revenue, ie EU taxes. This way there will be another level of government whose preferences are the result of an aggregation of the preferences of the populations of all EU member states, weighted by the machanics of the European parliament's electoral system.

This way, the greeks won't complain about Germany. They'll complain about Europe. And if Europe does not help them with structural funds, they'll burn EU flags or vote for more leftist representatives in the EP, who will be more generous with how they spend EU funds.

On a final note, this issue of the bail out from the EU has been a controversial topic since the beginning of the financial crisis, before it expanded to the rest of the economy. There's an interesting distinction that must be made. States can, under some circumstances bail each other out, the ECB cannot. Both the member states and the ECB can bail out the private sector. The explanation for this can be found in Article 104 of the Maastricht Treaty:

"ARTICLE 104

1. Overdraft facilities or any other type of credit facility with the ECB or with the central banks of the Member States (hereinafter referred to as ‘national central banks’)in favour of Community institutions or bodies, central governments, regional, local orother public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the ECB or national central banks of debt instruments.

2. Paragraph 1 shall not apply to publicly-owned credit institutions which, in the context of the supply of reserves by central banks, shall be given the same treatment by national central banks and the ECB as private credit institutions."

So if you are wondering why people talk about the help that the ECB gave to businesses during the financial crisis, it did so through paragraph 2. It provided credid facilities to "private and publicly owned credit institutions." In conclusion, member states can bail eachother and their private sector out. The ECB can also bail out the private sector but not country. The ECB can increase its credit lines to private institutions all over the Euro-zone, which may then buy credit from the state. So in principle, the ECB could bail a state out. However, it is rather unlikely that the ECB will provide a credit line exclusively to one bank of a specific country, which would serve as a proxy of the state, as this would be highly frowned upon. Alternatively, it could provide that credit line to everybody, but it seems very unlikely that all those banks would then flock to a troubled country and just hand that money to it.